Invoice finance is a form of business funding which allows companies to close cash flow gaps by raising funds using their accounts receivable ledger. This can be done by either selling outstanding invoices to an invoice financing company or by using them as security for a business line of credit.

Invoice finance can also be called debtor finance, receivables finance or accounts receivables finance. To make things more confusing, all of these terms are often used interchangeably to mean the same thing. There are two main types of invoice finance; invoice discounting and invoice factoring.

The history of invoice finance

In this article, we’ll take you through what invoice finance is, the types on offer to Australian businesses and then list some of their pros and cons.

Invoice finance and invoice trading have been around a long time, appearing in texts from the days of King Hammurabi and the Babylonians. The Babylonians were an inventive people and when they weren’t coming up things like writing, building boats and discovering the wheel, they were trading overdue debts for up-front cash. While the world may have changed a bit over the last 4,000 years, the basic premise of invoice finance has, more or less, remained the same.

Why invoice finance?

Invoice finance can be suitable for businesses of all sizes and in various industries, usually as long as they are raising invoices for goods and services upon completion. Here is an example of invoice financing may work.

A locally run manufacturer makes delicious apple cider. They’ve had some great news; their product has been selected by a national retailer and will join a major chain’s stock list. Our manufacturer produces a run of their cider, supplies it to the national retailer and sends along their invoice. The retailer insists on compliance with its standard payment terms of 45 days, as it does from all of its suppliers. The cidermaker is a small, locally run operation so waiting 45 days for their invoice amount to be paid creates a business cash flow problem. The cidermaker has had to pay for raw materials, their staff and all of their operational costs. Their business does not have the capacity to wait 45 days for payment of their invoice.

Invoice finance is a form of short-term cash flow finance secured against unpaid invoices like this one. It can be offered as a line of credit or a cash advance. This type of finance is designed to be used by businesses as a method for improving cash flow, purchasing equipment, inventory, and raw materials. It helps businesses to meet payroll obligations and to cover operational expenses.

When applying, the invoice financing company will want to know about the risk associated with the debtors, as well as the age and quality of the invoices. Other factors they consider are ageing (how old the invoices are) and concentration (how many debtors a business has). An accounts receivable ledger full of newer invoices spread over many debtors is more likely to be funded because the risk is lower than if the ledger contained a concentration of ageing invoices from a single debtor.

What are invoice discounting and factoring?

Let’s look at the two main kinds of invoice finance; factoring and discounting.

In invoice factoring, a business sells either a single invoice or all of their outstanding invoices to a factoring company (or factor). The business can usually access the first 70-85% of the funds for these invoices within 24 hours. This is known as an advance. The factor then takes responsibility for collection of the debt, managing that risk until the customer pays. Once the debt been paid, the factor will remit the outstanding amount (called the rebate) less any factoring fees they have charged for their service (which can range from 2-5%).

Invoice factoring is relatively easy to apply for and often used by small businesses experiencing cash flow problems. They may not have access to other types of business finance options like a business loan. The associated risk of the debt is also mitigated by the factoring company. The factor takes responsibility for collections and credit control. They manage payments, chase invoices due for payment and deal with customers.

Invoice discounting is another type of invoice finance option which uses the business accounts receivables ledger as collateral (or security) for a loan. The key difference between discounting and factoring is that the finance company remains hidden in the background, which means credit and collections remain the responsibility of the business. They assume the risk of managing that debt and collecting it, but more importantly, they keep control of those important customer relationships. If a small business has reliable debtors but payment terms which aren’t viable for the business, invoice discounting offers a discrete way of managing internal cash flow and maintaining comfortable and friendly debtor relationships.

Advantages and disadvantages of invoice factoring

Instant working capital boost - businesses can cover payroll, meet operational costs and expandMore expensive than other kinds of business funding
It grows with the business - as more invoices are raised the amount available increasesFunds available are capped by the total ledger value
Does not require a fixed asset, such as property, for securityCan involve long term contracts (often 2 years)
Saves time, as the factor manages credit control and collectionsCould potentially impact customer relationships
Offers security and protection against bad debtors (non-recourse facility)Your customers know you’re factoring
Compared to other types of business loan, factoring is relatively easy to obtainIt has a somewhat negative reputation

Advantages and disadvantages of invoice discounting

Instant working capital boost - businesses can cover payroll, meet operational costs and expandMore expensive than other kinds of business funding
It grows with the business - as more invoices are raised the amount available increasesUnlike factoring, no financial administration help from the lender – the debt risk is still owned by the business
Does not require a fixed asset, such as property, for securityFunds available are capped by the total ledger value
The lender doesn’t interfere with client relationshipsUsually suited only to larger companies
More often a short term optionSome lenders may require a commitment of a minimum term

The Waddle difference

Waddle offers a modern form of invoice financing. We've built an innovative receivables finance solution allowing businesses to close the cash flow gaps that are holding them back. The Waddle platform seamlessly connects with cloud accountancy platforms, like Xero & MYOB and generates a finance offer within a few clicks.

Once approved, Waddle offers an instant line of credit based on your unpaid invoices, which is adjusted in real-time as they are raised and paid. You pick the invoices to fund and only pay for those that you draw down. And thanks to the cloud accounting integration, bookkeeping is a breeze with no invoices to upload and instant reconciliation.

It’s also fully confidential, so your important client relationships stay with you. And Waddle offers the friendliest terms with no minimum monthly spend, no contracts or hidden fees, giving you fast and easy access to working capital with minimal fuss. Get an offer now!

Russ Watts

Digi Marketer, responsible for spreading the Waddle word far and wide. Writes the blogs, manages the ads & comes up with ways of making invoice finance sound exciting.

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